5 Ways U.S. Presidential Election May Impact Your Taxes

No matter the outcome in November of the race for the White House, tax reform will likely be a priority. We look at possible winners and losers of key proposals.

Election polls seem to fluctuate daily—as of late September, Hillary Clinton continued to hold the lead, with Donald Trump making some gains. What's more certain: Regardless of who's elected, tax reform will likely be a priority.

While control of the Senate is too close to call, the next U.S. President likely will encounter a Republican House of Representatives in January. If that's the case, then a Clinton presidency will likely face more-of-the-same gridlock, while a Trump presidency could result in faster change. But either candidate would likely find common ground with Congress on tax issues.

A recent Morgan Stanley report, "Tax to the Future," digs into the candidates' tax proposals and outlines the potential impact on markets, investors and individuals. As we speed toward the election, here are five ways the 2016 election may affect taxes.

1. The Middle Class Could See Relief

The candidates' approaches to personal taxes vary widely. Trump favors reducing the number of income tax brackets to three, with the highest topping out at 33%, well below the current 39.6% top rate. Clinton wants to add a 43.6% top tax bracket for the highest earners, and she supports the "Buffett Rule"—which calls for a minimum effective tax rate for millionaires.

However, both propose “increases in middle-class deductions and credits that may help the U.S. consumer," says Michael Zezas, Morgan Stanley's head of municipal bond strategy and lead analyst on the report. For example, both candidates are pushing increased tax credits for childcare expenses. Democrats want to expand the Earned Income Tax Credit, while Republicans want to raise the standard deduction. Each scenario would benefit consumers' bottom lines.

2. Asset Managers Could Pay More Taxes on Their Earnings

Both candidates call for eliminating the carried interest tax, which allows private equity and hedge funds to pay long-term capital gains rates on their performance fee earnings. Zezas says the risk is most pronounced under Clinton's plan because the Democratic candidate is aiming for a top income-tax bracket of 43.6%.

Trump, however, is advocating for a 15% corporate income tax, which, if applied broadly to pass-through business entities, could actually reduce taxes for asset managers, according to the report.

3. Trump's Tax Plan Could Lead to Muni Market Headache

The municipal bond market may shed some of its appeal under a Trump presidency. The Republican candidate proposes cutting marginal tax rates, which Zezas says dampens the key selling point of munis—their tax-exempted interest—because lower rates would reduce the amount of tax liability today's muni investor is shielded from. In addition, the Republicans' tax proposals include capping tax deductions and exemptions, which could also reduce the tax advantages of muni bonds.

Both initiatives could cause the demand for bonds to drop, yields to rise and potentially prompt a sell-off reminiscent of 2013, according to the report. “The greater odds of a Trump victory would make us more cautious about this asset class overall," Zezas says.

4. Corporate Tax Reform Could Be a Win for Domestic-Focused Companies

International taxation is a complex issue, but broad corporate tax reform would likely tackle some of its hot spots. Most notably, U.S. multinational corporations have as much as $2.5 trillion stashed overseas, sheltered from domestic taxes. “While the details are limited, a key area of consensus between Clinton and Trump is the need for tax reform of foreign-source income," Zezas says.

Both candidates say they'd want to tax corporate income on a global basis, and stop U.S. companies from deferring income from their foreign subsidiaries. Clinton has also proposed creating an “exit tax" to deter U.S. companies from "inverting" their headquarters to lower-tax countries. Likely winners: Domestic-focused companies that aren't affected by international tax issues and, under a Trump or Clinton presidency, could benefit from lower corporate tax rates, says Accounting Strategist Todd Castagno.

Repatriation is on the table for both parties. And despite the one-time tax hit, having that cash close to home offers some positives for credit investors—primarily, increased access to liquidity. “Our view does hinge on how corporations eventually spend those repatriated earnings, which can be hard to predict," Zezas says.

For more Morgan Stanley Research on U.S. tax policy and the 2016 presidential election, ask your Morgan Stanley representative or Financial Advisor for the full report, "Tax to the Future" (Sep 13, 2016). Plus, more Ideas.

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